Bank of Canada’s recent interest rate decision is a hard act to follow.
In a move that’s becoming far more commonplace in recent times with major economies around the world, the Bank of Canada (BoC or Banque du Canada) this past Wednesday 13th July announced its newest monetary policy, including a substantial rate hike. In the 24 years since 1998, Canada has not seen a single rate increase this high: a full 100 basis points up to 2.5% from 1.5%.
The increase itself was not at all unexpected, as it was the fourth in a row now since March, and many economists were predicting a rise of up to 75 basis points, but if anyone was thinking that the central bank had been too soft previously with its policies to curb escalating inflation, which is now at a staggering 40 year high, then this broad move now confirms how serious they are.
What’s behind the increase?
From the press conference in Ottawa, Ontario, following the meeting, the Bank’s Governor, Tiff Macklem, addressed reporters and began explaining that there were three dominating factors at play behind the almost unprecedented move.
“First, inflation is too high, and more people are getting more worried that high inflation is here to stay. We cannot let that happen. Restoring price stability—low, stable, and predictable inflation—is paramount.”
The governor continued. “Second, the Canadian economy is overheated. There are shortages of workers and of many goods and services. Demand needs to slow so supply can catch up and price pressures ease.”
“And third, our goal is to get inflation back to its 2% target with a soft landing for the economy. To accomplish that, we are increasing our policy interest rate quickly to prevent high inflation from becoming entrenched. If it does, it will be more painful for the economy—and for Canadians—to get inflation back down.” He said.
The Governor then went on to explain that the drivers of the country’s almost 8% inflation were similar worldwide. The ongoing conflict in Ukraine, issues with supply chains and bottlenecks, China’s lockdowns as a result of the pandemic, and higher energy prices.
Commenting for Reuters on the news of the rate hike, market analyst at the specialist in commercial foreign exchange Monex Canada, Jay Zhao-Murray, explained that this move was quite a significant one, as it was clear the Bank was willing to deviate from the Fed and its policies.
“They are improving the interest rate differential for Canada and that should help with the exchange rate channel and block out some of that external inflation.” He said.
On the forecast for the economy, the Bank of Canada stated in its official release that they expected 3.5% growth in 2022, with global factors impacting the leveling out of supply and demand. They also predict drops of energy prices, and an easing of inflation starting later this year would bring economic activity back to a slower pace, with a hopeful increase of 1.75% in 2023 and 2.5% in 2024.
Canadians will be feeling the pinch.
Those hit hardest by the higher rates will most certainly be homeowners, as their variable rate mortgages closely track the central bank’s rates. Many Canadians took advantage of record low rates (some less than 1%) during the pandemic and the housing market was extremely competitive as a result.
For those that may have taken on too much debt to enter the housing market at the time, there will be tough times to come as the BoC has forecasted more rate hikes in the next few months.
On this point, the Bank’s official statement read “The Governing Council continues to judge that interest rates will need to rise further, and the pace and increases will be guided by the Bank’s ongoing assessment of the economy and inflation.”
As of Thursday morning, two of the nation’s major banks have already adjusted their benchmark rates as a response to the move. TD and Royal Bank increased their prime lending rates up to 4.7% from 3.7% and it’s expected that the other big banks will follow in the coming days and weeks.
Governor Macklem assured in the closing of his remarks that the decision to raise rates so sharply was not one that was made lightly, and that the board was aware of the strain on Canadians who were already feeling the pain of high inflation.
“It can seem counterintuitive to add to the interest cost Canadians face in order to combat the cost of inflation. But by increasing the cost of borrowing we will moderate spending and return inflation to target.” He later continued. “The way to protect people from high inflation is to eliminate it. That’s our job, and we are determined to do it. The Governing Council is resolute in its commitment to price stability.”
How did the CAD react?
While the Loonie initially strengthened against the USD, yesterday’s US PPI figures show that inflation at the wholesale level in June increased 11.3% compared to a year earlier, propelling the USD and sending the USD/CAD pair to a fresh high since November 2022 at around 1.3126 at the time of writing (touching 1.3223 at its highest point yesterday).
The market sentiment feature of the ActivTrader platform from ActivTrades shows that the community is divided regarding the direction of the USD/CAD, as both central banks are adopting aggressive stances to curb inflation. 41% of the community is buying the pair, while 59% is selling it.
Next week, volatility on the pair might be higher with the release of Canadian CPI on Wednesday and Canadian retail sales on Friday, as well as US Service PMI on Friday.
Daily USD/CAD chart with Ichimoku and RSI - Source: Online ActivTrader platform with Market Sentiment.
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